Gold Rush Investor

A resource for those interested in investing in natural resources, especially GOLD.

Thursday, December 15, 2005

The Rainwater Prophecy

Fortune has a good article about the worries of billionare investor Richard Rainwater:

Richard Rainwater doesn't want to sound like a kook. But he's about as worried as a happily married guy with more than $2 billion and a home in Pebble Beach can get. Americans are "in the kind of trouble people shouldn't find themselves in," he says. He's just wary about being the one to sound the alarm.

Rainwater is something of a behind-the-scenes type—at least as far as alpha-male billionaires go. He counts President Bush as a personal friend but dislikes politics, and frankly, when he gets worked up, he says some pretty far-out things that could easily be taken out of context. Such as: An economic tsunami is about to hit the global economy as the world runs out of oil. Or a coalition of communist and Islamic states may decide to stop selling their precious crude to Americans any day now. Or food shortages may soon hit the U.S. Or he read on a blog last night that there's this one gargantuan chunk of ice sitting on a precipice in Antarctica that, if it falls off, will raise sea levels worldwide by two feet—and it's getting closer to the edge.... And then he'll interrupt himself: "Look, I'm not predicting anything," he'll say. "That's when you get a little kooky-sounding."

Rainwater is no crackpot. But you don't get to be a multibillionaire investor—one who's more than doubled his net worth in a decade—through incremental gains on little stock trades. You have to push way past conventional thinking, test the boundaries of chaos, see events in a bigger context. You have to look at all the scenarios, from "A to friggin' Z," as he says, and not be afraid to focus on Z. Only when you've vacuumed up as much information as possible and you know the world is at a major inflection point do you put a hell of a lot of money behind your conviction.

Such insights have allowed Rainwater to turn moments of cataclysm into gigantic paydays before. In the mid-1990s he saw panic selling in Houston real estate and bought some 15 million square feet; now the properties are selling for three times his purchase price. In the late '90s, when oil seemed plentiful and its price had fallen to the low teens, he bet hundreds of millions—by investing in oil stocks and futures—that it would rise. A billion dollars later, that move is still paying off. "Most people invest and then sit around worrying what the next blowup will be," he says. "I do the opposite. I wait for the blowup, then invest."

The next blowup, however, looms so large that it scares and confuses him. For the past few months he's been holed up in hard-core research mode—reading books, academic studies, and, yes, blogs. Every morning he rises before dawn at one of his houses in Texas or South Carolina or California (he actually owns a piece of Pebble Beach Resorts) and spends four or five hours reading sites like LifeAftertheOilCrash.net or DieOff.org, obsessively following links and sifting through data. How worried is he? He has some $500 million of his $2.5 billion fortune in cash, more than ever before. "I'm long oil and I'm liquid," he says. "I've put myself in a position that if the end of the world came tomorrow I'd kind of be prepared." He's also ready to move fast if he spots an opening.

His instincts tell him that another enormous moneymaking opportunity is about to present itself, what he calls a "slow pitch down the middle." But, at 61, wealthier and happier than ever before, Rainwater finds himself reacting differently this time. He's focused more on staying rich than on getting richer. But there's something else too: a sort of billionaire-style civic duty he feels to get a conversation started. Why couldn't energy prices skyrocket, with grave repercussions, not just economic but political? As industry analysts debate whether the world's oil production is destined to decline, the prospect makes him itchy.

"This is a nonrecurring event," he says. "The 100-year flood in Houston real estate was one, the ability to buy oil and gas really cheap was another, and now there's the opportunity to do something based on a shortage of natural resources. Can you make money? Well, yeah. One way is to just stay long domestic oil. But there may be something more important than making money. This is the first scenario I've seen where I question the survivability of mankind. I don't want the world to wake up one day and say, 'How come some doofus billionaire in Texas made all this money by being aware of this, and why didn't someone tell us?'"

It feels like the last place you'd go looking for a rich man. Lake City, S.C., is a town of 6,500 in the low country two hours northwest of Charleston. Once the bustling home to small, independent tobacco farmers, now it's mostly a collection of abandoned gas stations, roadside churches, and fading brick walls with trust jesus painted on them in big black letters. Unemployment hovers around 10% and would be worse if the Taiwanese plastics manufacturer Nan Ya hadn't opened up a sprawling factory on the edge of town.

Rainwater spends a lot of time in Lake City because of his wife, Darla Moore. A former star in bankruptcy financing at Chemical Bank who was once dubbed the "toughest babe in business" by Fortune, Moore, 51, grew up here. Her grandfather was one of the small tobacco farmers. Nowadays she lives on her grandparents' old farm. (Moore and Rainwater also own a lavish home in Charleston.) Rainwater calls Lake City the "middle of bum-fuck nowhere." But the truth is he's got everything he needs here: cable TV, a telephone, an automatic coffeemaker, a decent golf course up the road, and a fast Internet connection.

Measured against the languid pace of the surroundings, Rainwater's usual surplus of physical energy seems even more pronounced in Lake City. Tall, tan, and sturdily built, he has a hard time sitting still. He's run four marathons and offers that, when he was 40, he unexpectedly set the record in his age group on something called a "modified Balke protocol" treadmill test, a measure of the body's efficiency in absorbing oxygen. Rainwater bounces around the farm in shorts, a polo shirt, and a baseball cap, maintaining a running dialogue with Moore (whom he calls "Precious"), his staff, and anyone else who happens to be within earshot or on his speed dial. "He's maternal," says Moore. "And I'm paternal."

In the ongoing Richard and Darla show, Moore supplies the dry one-liners to his constant chatter. Lately she's been affectionately calling him "Dr. Doom." But she's not dismissing his concerns. Or harboring any illusions that she can talk him out of making a big investment once he settles on a theme. As president of Rainwater Inc. in the '90s, she was his partner in his last two big bets. And though she's at a stage in life where she might prefer to simplify her affairs rather than go off on another wild ride, she knows that soon he'll have to act. "We've been married for 15 years," she says. "This is the third time I've seen this. The massive intake of information has been complete. Now he's agonizing. We're in what I refer to as the raving mode—the latter stages of rave. This is the refinement stage. Then we're going to make decisions."

"It's not raving," he says. "I promise I am not a kook."

"You're kooking out a little. But I've seen the process before. I saw you go from zero to 100 miles per hour in real estate."

"And you saw me get into oil ten years ago," he says, then protests, "But I'm on the edge of being so old that it doesn't matter anymore. I've won the heavyweight championship before. Instead of taking one more swing, maybe I should just retire a winner." Moore's not buying it. "Buckwheat," she says, using her nickname for him, "There's not a chance in a million you won't swing. He can't not. It's the nature of the animal."

"Rainwater," the voice on the phone announces. "Now, type L-A-T-O-C into Yahoo, and scroll down to the seventh item." Rainwater doesn't use e-mail. Rather, he uses rapid-fire phone calls to spread the gospel he discovers every morning on the web. One day it might be the decline of arable land in Malaysia. The next it could be the Olduvai theory of per capita energy consumption. "L-A-T-O-C" stands for LifeAfterTheOilCrash.net, a blog edited by Matt Savinar, 27, of Santa Rosa, Calif. (which Rainwater calls "a hotbed for survivalist types"), who was on his way to being a lawyer when his side project began climbing up Google's rankings. The site is now the No. 2 result of a search on "oil." Savinar keeps a running diary of all manner of news and information relating to "peak oil," a once-wonkish geological debate that has recently crossed over not only to late-night talk shows but even onto the floor of the U.S. House of Representatives.

"Peak oil" theorists posit that global production is at or near its historic ceiling and will begin a long, inexorable decline. They worry that America is not ready for the downturn, for skyrocketing prices and even shortages. Savinar's site's opening line is, "Civilization as we know it is coming to an end." Rainwater has been checking it every morning since September, when his personal anxiety alert level moved to orange. "I can almost pinpoint the date," says Moore. "It was right after he read that book."

In August a friend gave Rainwater a copy of The Long Emergency, a dystopic view of the future written by ex-Rolling Stone writer James Kunstler, otherwise known for his passionate dislike of suburbia. Taking peak oil as a given, Kunstler argues that Americans have been "sleepwalking" through the end of a "100-year fossil fuel fiesta." The problem, he points out, is not that the world will run out of oil tomorrow, but rather that the lack of growth in oil production will wreak havoc on a global economic system predicated on perpetual expansion. Kunstler's "long emergency" is a decidedly unpleasant interval during which the world—and Americans in particular—must adapt to a post-oil regime of scarce energy and economic stagnation, a time of likely wars and the disappearance of all-American things like Wal-Mart and cul-de-sac homes 45 minutes by minivan from the office.

Rainwater doesn't completely buy into Kunstler's doom and gloom. "It's the Z scenario," he says. But at the same time, he worries that Kunstler isn't wrong enough, and he's been buying extra copies of the book and passing them around to the many titans of capitalism who are his protégés. It's not the first doomsday book in Rainwater's life: His big bet on oil in the late '90s was kicked off by a work called Beyond the Limits, the sequel to a '70s sensation called The Limits of Growth. Written by three professors armed with an MIT-bred computer called World3, the Limits books projected that, left unchecked, human population would, within 100 years, overshoot the capacity of the planet to serve up sufficient vitamins and minerals—let alone absorb all the waste and pollution—to keep everyone healthy. Rainwater took the book to heart. "Right after I read it, I said, 'They've figured it out, I'm going to follow this thing.' "

His ensuing oil bet was only the latest triumph for the grandson of a Lebanese immigrant (on his mother's side) who, according to family lore, picked up his last name from a Cherokee ancestor. His mother had worked at J.C. Penney to put him and his brother through the University of Texas. In 1970, after a short stint at Goldman Sachs, he joined Stanford Business School pal Sid Bass in managing the Bass family money in Fort Worth. Over the next decade and a half, he helped turn the family's modest $50 million fortune into one worth upwards of $5 billion.

In the process Rainwater's investing style emerged: analytically rigorous but opportunistic and Texas-sized in its audacity. He'd buy public companies or private. He'd use futures and leverage, sometimes 20 to 1. He even started companies. If he thought an idea was right, he put capital behind it. With the Basses, he resurrected the likes of Disney—recruiting Michael Eisner to be CEO—and bet early on cellphones. Later, when he went out on his own in 1986, his office drew a who's who of hard-charging capitalists to Fort Worth. In the heyday of Rainwater Inc., Eddie Lampert, the hedge fund tycoon turned head of Sears Holdings, had a desk, as did Daniel Stern, now of $3 billion Reservoir Capital. Ken Hersh, who has compounded money at 31% annually for 17 years at Natural Gas Partners, started there. With Rick Scott, Rainwater founded Columbia Healthcare, which merged with HCA and became the country's biggest for-profit hospital company (Scott was later forced out as CEO amid a federal fraud investigation). Even George W. Bush kept an office, when he and Rainwater were putting together the Texas Rangers stadium deal.

On a Tuesday afternoon in mid-November, Rainwater and Moore are holding court in the 14th-floor conference room of Reservoir Capital in Midtown Manhattan, where he camps out when he's in New York (he has money invested with the fund). He has gathered Reservoir's Stern, Goldman alum and Crestview Partners co-founder Barry Volpert, and a couple of guests, and he is expounding on the implications of the peak-oil theory: "I believe in Hubbert's Peak. I came out of Texas. I watched oil fields reach peak and go over, and I've watched how people would do all they could, put whatever amount of money into the field, and they couldn't do anything about it."

In the 1940s and 1950s, a Shell geologist named M. King Hubbert observed that the production from any given oil field follows a bell curve, with annual volumes increasing until half the oil in the field is depleted, and declining thereafter. Basically, the bottom oil is harder to extract. King reasoned that production from all U.S. fields would follow a similar curve and predicted in 1956 that total U.S. oil production would peak in the early 1970s. His analysis caused a furor and was widely disparaged, but proved correct. "Hubbert's Peak" entered the lexicon of oil analysis—one of the great geological I-told-you-so's. Forty-nine years later, a growing number of noted geologists and industry analysts suggest that the global oil supply may now be topping out, a claim that has been met by skepticism from yet other geologists and economists who say higher prices will spawn both more discovery and improved recovery from existing fields.

Rainwater sides with the imminent peak crowd, and can rattle off facts to back up his argument. "In 1988 there were 15 million barrels a day of shut-in production"—meaning surplus that could be tapped—"and the world was using about 55 million barrels of oil. Today the world is using over 80 million, and there's no shut-in production left. We've used it up, through the combination of depletion and growth." In other words, the spigot can't be opened any wider.

What concerns him most is the conflict that he thinks an oil shortage will precipitate. What happens when people get blindsided by prices rocketing past any level they have contemplated—especially when you factor in other challenges America faces? "We've got a lot of things going on simultaneously," he says. "The world as we know it is unwinding with respect to Social Security, pensions, Medicare. We're going to have dramatically increased taxes in the U.S. I believe we're going into a world where there's going to be more hostility. More people are going to be asking, 'Why did God do this to us?' Whatever God they worship. Alfred Sloan said it a long time ago at General Motors, that we're giving these things during good times. What happens in bad times? We're going to have to take them back, and then everybody will riot.' And he's right."

Part of Rainwater's routine when he's down on the farm is to go for gizzards at Allison's, a no-frills truck stop up the road. Driving in a red BMW SUV on the Tuesday before Thanksgiving, he points out who lives where: the local doctor, the Taiwanese Nan Ya workers. He chokes up momentarily passing the home of a woman who worked at the farm, whose son has just returned from serving in Iraq. The sheer incongruity of his wealth in Lake City is not lost on him. But at Allison's he seems right at home, lathering the deep-fried gizzards with hot sauce and self-serving a large coffee which he spices at the hot chocolate machine.

Back on the farm that night, he and Moore discuss future projects with their landscaper, Jenks Farmer, over a glass of wine. Farmer, who has a master's in horticulture and lives on the property, maintains Moore's extensive gardens, including vegetable beds that produce all year round. That morning Rainwater had been surfing the web, researching greenhouses in his quest to further ensure a steady flow of food through the winter. At his prodding, Moore has installed an emergency generator and 500-gallon storage tanks for diesel fuel and water. When Rainwater says that he's thinking about opening a for-profit survivability center, it's not entirely clear that he's joking.

Later in the night Rainwater returns to musing on how different his lot is from the residents of Lake City. And then, returning to the debate in his head, he gets a serious look on his face and says: "This is going to get a little religious. I ask why I was blessed with this insightfulness. Everyone who has achieved something, scientists, ballplayers, thinks they were given their talent for a reason. Why me? Was I given this insightfulness at this particular time? Or was I just given this insightfulness?" He pauses. "I just want people to look out. 'Cause it could be bad."

Marc Fabers thoughts

From recent US Federal Reserve Board meeting minutes, it would appear that monetary policies will move from a tightening bias to a neutral or easing mode within the next six months or so. In the past, I have maintained that the US, with a debt-to-GDP ratio of over 300%, has no other option but to print money (see figure 1).

Figure 1: Total Credit Market Debt as % of US GDP, 1916 - 2005

Source: Bridgewater Associates

Tight money policies, which would depress asset prices such as stocks and home prices is simply not an option the Fed will consider. As a result, inflation will continue, whereby I am using here inflation as defined by a loss of the purchasing power of paper money. At times, such as in the 1970s, this loss of purchasing power of money is brought about by rapidly rising consumer prices, while at other times, such as in recent years, the purchasing power of money diminishes because real estate, stock, art and bond prices increase significantly. In both cases, under consumer price or asset price inflation, your dollar today can only buy a fraction of what it bought ten or twenty years ago (see figure 2)

Figure 2: Purchasing Power of US Dollar, 1800 - 2005Source: Barron’s

What is remarkable about figure 2 is that for as long as there was no Federal Reserve Board – that is between 1800 and 1913, the purchasing power of the dollar was more or less constant. However, as soon as the Fed was formed in 1913, the purchasing power began to decline – in fact by 92% over the last 100 years or so.

Now, considering that Household Net Worth is at an all time high and that rising home, and equity prices in the last twenty years or so drove the US economy up and the household saving rate down (now negative), Mr. Bernanke will under no circumstance allow asset prices to decline much (see figure 3)

Figure 3: Household Net Worth, 1950 - 2004Source: Merrill Lynch

Just imagine what the Fed’s reaction would be if both the Dow Jones and housing prices dropped by 10%! Money printing would be back in earnest because the Fed believes (erroneously, I may add) that it has the power to indefinitely postpone recessionary periods.

Now, if the Fed prints money, all asset prices will rise in nominal terms whereby some prices will rise more than others, while the currency of the money printing country – the US – will weaken. The only problem for us investors is to recognize and forecast, which prices will increase the most, consumer prices or asset prices, and if asset price inflation continues, as occurred in the past twenty years, specifically which asset prices will move up the most. Moreover, if the US dollar weakens it is important to define against what the dollar will depreciate.

The importance of being invested in the “right asset class” is evident from the diverging performance of the Hang Seng Index or of Hong Kong property prices and oil since 1997. So, whereas the Hang Seng Index and Hong Kong property prices have not risen, since 1997, crude oil is up by more than four times! I would expect similar diverging performances among different asset classes to emerge in future as well. In particular, I am a believer that at some point in future, investors will lose faith in the value of US dollar denominated bonds and in the US dollar. At such time, investors will drive US interest rates much higher resulting in tumbling bond prices and rush into anything but US assets such as equities and bonds. This does not mean that all US dollar assets will collapse in nominal terms, but they could collapse against a “hard currency” such as gold or possibly against non-US dollar currencies, provided foreign central banks pursue tighter monetary policies than the US. This, however, is an issue about which we cannot really be certain, as all central bankers have a propensity “to print money”. Therefore, I feel that asset prices will tend to depreciate against the only currencies for which the supply is limited – gold, silver, and platinum.

I have shown the Dow/Gold ratio in the past but would like to expand on this theme. As can be seen from figure 5, the Dow/Gold ration has fluctuated over time between 1 and almost 45. When the Dow/Gold ratio was under five, gold was expensive and equities were cheap. Conversely, when the Dow/Gold ratio was over 20, stocks were expensive and gold relatively cheap (see figure 5).

Figure 5: Dow/Gold Ratio, 1900 - 2005Source: www.sharelynx.com

Now, it is interesting to observe what has happened since 2000. At the peak of the stock market in March 2000 the Dow/Gold ratio stood at close to 45. In other words, it was for a “gold money” holder very expensive to buy one Dow Jones Industrial Average since it took 45 ounces of gold to buy the Dow. Thereafter, stocks collapsed into October 2002 and, therefore, the Dow/Gold ratio also declined. What is, however, interesting is that despite the stock market’s rebound since October 2002, the Dow/Gold ratio has continued to decline. Simply put for the holder of gold - the world’s only honest currency, since it cannot be printed by some dishonest central banker – the Dow, although it increased in value in dollar terms, has continued to decline in gold terms with the result that, today, it “only” takes 20 ounces of gold to buy one Dow Jones Industrial Average. Simply put, since 2000, gold has risen at a much faster clip than the Dow Jones and I would expect this out-performance to continue for the next few years until “gold currency” holders will be able to buy one Dow Jones with just one ounce of gold.

So, if Mr. Bernanke does what he believes in – namely that asset deflation has to be avoided at all cost and, therefore, massively prints money, no matter where the Dow will be in future, at 36,000, 40,000, or at 100,000, as some pundits predicted in their in 1999 published books (of course shortly before the market tumbled), you will be able to buy the Dow with ounce of gold worth either $36,000, $40,000 or $100,000.

Now, you may think that I have become insane. That is partially true because I am convinced that the US Fed’s monetary policies will lead to exponentially widening wealth inequity and impoverish the majority of US households, which will then lead to social strive, protectionism, war, and the breakdown of the capitalistic system. However, if one considers that in 1932 and in 1980 (see figure 5) one could indeed buy one Dow Jones Industrial Average with just one ounce of gold, then maybe my views are rather conservative. Possibly one will be able to buy, sometime in future, one Dow Jones with just half an ounce of gold!

Therefore, rather than to buy US stocks, I suggest to invest in gold, whereby right now, both the Dow and gold, as well as most other investment markets are significantly over-bought and could easily correct by about 5% to 10% on the downside.

There are some more issues we need to address. What about if the “deflationists” such as my friend Robert Prechter, whose arguments I highly respect, are correct and deflation brings down the Dow Jones, home prices, and all other assets by 50% or 90% in value? In such a scenario, I would expect that there would be serious debt defaults, a collapse of the derivatives market, and an imaginable banking crisis leading investors to rush into an asset that is not a liability of somebody else. Therefore, I believe that if the Dow Jones declined to say 5,000, gold might actually rally further.

What about the US dollar’s value against other currencies? This year the US dollar has been strong, but I would expect other currencies to strengthen against the US dollar once the market realizes that the Fed will print again money. At the end of 2004, investors bet heavily against the US dollar and sentiment about the dollar was extremely negative. Today, however, we have the opposite situation with speculators being extremely positive about the dollar and negative about non-US dollar currencies. In fact, the speculative positions on the dollar stand at a record high (see figure 6).

The Committee judges that some further measured policy firming is likely to be needed to keep the risks to the attainment of both sustainable economic growth and price stability roughly in balance. In any event, the Committee will respond to changes in economic prospects as needed to foster these objectives.

In a related action, the Board of Governors unanimously approved a 25-basis point increase in the discount rate to 5-1/4 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, Kansas City, Dallas, and San Francisco.

Tuesday, December 13, 2005

What is this place?

I've decided to create a blog to share my thoughts on gold investing. Who am I? Just a guy that has been investing for a while and has became a "new" gold bug when the current secular bull began in 2001.

When John Mauldin first started writing his weekly newsletters, he said it was mostly an exercise for himself, in that it forced him to keep up with the latest market news/action. While I am by no means an investment professional, I'm hoping that using this site as a repository of all the interesting info I come across will help myself as well as anyone else interested in riding this bull market.